Economic Inequality,War Finance and the Pursuit of Tax Fairness

Introduction: Tax Fairness and War Finance

It is widely acknowledged that a fair tax system is one of the most crucial foundations for any country to pursue stable development and human values. When a country’s tax policies are perceived unfair, citizens are likely to engage in serious tax revolts and society could be severely divided. As a result, the government is likely to lose its legitimacy and revenue, causing it less capable of providing public goods and protecting human rights. In modern times, countries perceived to have less fair tax systems, including the United States and European matured democracies, usually face the problems of rising inequality and populism. Therefore, scholars, public intellectuals, international organizations and policymakers all urge countries to reform tax systems, close legal loopholes and make the systems fairer, more progressive and just (Buffet, 2011; Krugman, 2019; Lagarde, 2019; Piketty et al., 2018; Stiglitz, 2019).

So how does a country accomplish tax fairness? A general consensus is that a fair tax system should at least adhere to the ‘ability to pay’ principle: Those with more income should be able to pay a higher rate of tax (Scheve & Stasavage, 2016, pp. 26–33). If the super-rich—the top 1 per cent—pay a lower rate than ordinary people do, the system is usually perceived unfair. This suggests an important implication: In a modern society, a fair tax system tends to be progressive, requiring the government to put higher tax burdens on the wealthy. A critical question emerges: Given that the wealthy usually possess more resources and higher capacity to penetrate the political process, how could a government successfully tax them?

Historically, war tends to create opportunities for countries to tax the rich heavily. Income tax was introduced in England during the Napoleonic Wars (Panitch, Head, Osberg, Green & Cassin, 1993). The United States imposed the first federal income tax during the Civil War (Razaghian, 2004). Many belligerents in the two World Wars increased top income tax rates substantially (Scheve & Stasavage, 2010, 2012, 2016, pp. 54–63). Because war not only causes a substantial demand for revenue but also raises a society’s fairness concerns about shared sacrifices, policymakers are more likely to enact progressive tax reforms during wartime (Scheve & Stasavage, 2016).

However, a puzzling change has occurred in the pattern of war finance. Since the 1970s, deficit financing strategy (including domestic and foreign borrowing) has become the dominant means for paying for interstate conflicts, while taxation has disappeared from great powers’ war finance portfolios (Bakhtiari, 2016; Tilly, 1975; Zielinski, 2016, pp. 107–111). The United States is a case in point. Taxation used to be one of the United States’ main war finance strategies in World War I, World War II and the Korean War (Kriner, Lechase & Cappella, 2018, p. 2; Zielinski, 2016). The wars in Iraq and Afghanistan, however, have been funded entirely by domestic and foreign debt (Bank, Stark & Thorndike, 2008; Flores-Macias and Kreps, 2013; Zielinski, 2016). Also, since his inauguration, President Donald Trump has engineered the ‘largest tax cuts’ since the end of the Cold War while seeking a ‘historic’ increase in military spending. Despite ferocious resistance, President Trump attempted to balance the defence boost by cutting discretionary domestic and foreign aid programmes, ranging from Social Security and Medicare to funding for global health and environmental programs (Wall Street Journal, 2017). As a result, more and more Americans perceive the US tax system unfair. According to the Pew Survey (2015, 2017, 2019), more than 60 per cent of Americans think some corporations and wealthy people do not pay their fair share in taxes. Other countries also reveal similar patterns. What has caused the great transformation of war finance in modern times? What has impeded countries’ efforts to enact progressive tax reforms during wartime since the 1970s?

This article argues that domestic economic inequality is one of the major causes behind the transformation. This article develops a theory, termed a ‘redistributionist theory of war finance’, to explain how states choose among the four principal financing instruments during wartime: (1) taxation, (2) reduction in non-military spending, (3) borrowing and (4) money creation. Fundamentally, inequality shapes state choices of war finance by affecting fiscal bargaining among three sets of domestic actors during wartime: the leadership, the wealthy elite and the public. Wars typically entail huge costs and sacrifices, in which the distribution of the war burden becomes a source of social instability. Faced with the exigencies of war, political leaders need to secure a fiscal bargain that sustains the sacrifices of competing societal coalitions without generating severe upheavals. When inequality is low, or when there is a persistently declining trend in inequality, the leadership is more likely to secure a consensus of ‘equality of fiscal sacrifice’ between the wealthy elite and the public. As a result, the leadership can more successfully enact progressive taxation and money creation, and reduce non-military spending to pay for the war. Conversely, when inequality is high, the societal redistributive conflict could be more serious. Unable to strike a bargain of fiscal sacrifices without severe social instability, the leadership is expected to resort to a debt financing strategy.

This article has important implications for the pursuit of tax fairness and democratic accountability. Eighty years ago, John Maynard Keynes urged the UK to resort to progressive taxation to pay for World War II. In How to Pay for the War Keynes stated (1940, p. iii, p. 1): ‘I have endeavoured to snatch from the exigency of war positive social improvements… I propose a plan conceived in a spirit of social justice in a time of general sacrifice’. Because the trend of inequality in the UK was persistently declining during the two World Wars (Scheidel, 2017, ch. 5), the UK accepted Keynes’ plan and maintained a relatively fair tax system until the 1970s. However, rising inequality has made the UK no longer able to ‘snatch social improvements from the exigency of war’. As a result, the UK did not raise any tax to finance the cost of the second Iraq War of 2003 (Chilcot, 2016). By shying away from raising taxes to pay for wars, the United States and UK were able to circumvent, by and large, internal checks and balances when pursuing aggressive and imprudent foreign policies and military doctrine. This may cause concerns about financial instability and a lack of democratic accountability.

The remainder of the article proceeds as follows. In the next section, I provide a general review of the literature on war finance. Then, I identify the associated redistributive consequences of each war finance strategy. In section 3, I develop a theory, which I term a ‘redistributionist theory of war finance’, to elaborate on how domestic inequality affects states’ war finance. In section 4, I present evidence from United States’ war finance choices in the Korean and Vietnam Wars. The last section concludes.

War Finance Strategies and Literature

The literature on war finance can be divided into three categories in terms of analytical focus: preferences of domestic interest groups, institutions and international/structural factors.

Focusing on domestic preferences, Gustavo Flores-Macias and Sarah Kreps (2013) argue that partisanship is a crucial factor in the US’ choice of war taxation. Kreps (2018) further points out that political leaders will favour the war finance strategy that best mirrors anticipated public attitudes. Rosella Cappella Zielinski (2016, pp. 18–23) suggests that leaders are more likely to tax when public support for the war is high. Kenneth Scheve and David Stasavage (2010, 2012, 2016) argue that mass mobilization for warfare itself could create a demand for progressive taxation as a means of ensuring greater equality of sacrifice in the war effort.

Concerning the literature emphasizing institutional dimensions, Kenneth Schultz and Barry Weingast (2003) argue that democracies are more likely to rely on borrowing in international power competition or fighting because they may enjoy better access to credit and more favourable terms. The reason, the authors argue, hinges on democratic checks and balances settings, which decrease the likelihood of default. They pioneered the democratic advantage theory research agenda in IPE. ¹ Carter and Palmer (2016) find that autocracies are more likely to reduce non-military spending to finance war efforts. Besides regime type, according to Paul Poast (2015), the establishment of central banks encourages states to rely on borrowing. Besides, Rosella Cappella Zielinski (2011, 2012, 2016, pp. 23–27) also points out that a state with low bureaucratic capacity or resource is unlikely to dependent on taxation to pay for the war.

Finally, an emphasis on international factors is also common in the literature. For example, Kirshner (2007, pp. 221–222) implies that financial globalization might make states more likely to rely on debt financing in the fighting. Rosella Cappella Zielinski (2013) argues that international reserve currency status may enhance the state’s borrowing capacity. Oatley (2015) studied US war finance and argues that American international financial power enables the US government to predominantly rely on the deficit financing strategy to pay for post-war military build-ups. Essentially, both Cappella and Oatley echo Benjamin Cohen’s notion of monetary power (Cohen, 2015).

The aforementioned works made valuable contributions to the studies on war finance. However, they do not adequately address the role of domestic economic inequality. The neglect of economic inequality is surprising since much of the literature explicitly or implicitly indicates that war finance policies have profound redistributive effects (Flores-Macias and Kreps, 2013; Scheve & Stasavage, 2016; Shea, 2014, pp. 772–774; Slantchev, 2012, p. 801; Zielinski, 2016, p. 8). For example, Piketty in his classic Capital in the Twenty-First Century (2014) alludes to the crucial relevance of inequality to any analysis of war finance. ²

As the Meltzer-Richard model (1981) implies, higher inequality is expected to cause a stronger demand for redistribution. Therefore, it could exacerbate redistributive conflict and political polarization. This, in turn, could cause an impact on partisanship, regime, bureaucratic capacity and international monetary power. More importantly, it could affect states’ war finance choices. To better understand the causal impact of inequality, we need to know the redistributive consequence of each war finance strategy.

The Redistributive Implications of War Finance

Conventionally, states may be said to have five possible instruments to finance war costs: taxation, reduction of non-military spending, domestic borrowing, foreign borrowing, and money creation. Each is associated with specific costs and redistributive consequences.

A Redistributionist Theory of War Finance

How does domestic economic inequality affect a state’s war finance strategy? I argue that the choice of war finance results from triangular strategic interactions among three sets of domestic actors—the political the leadership, ⁸ the wealthy elite, ⁹ and the rest of a state’s population, the general public or ordinary citizens. ¹⁰ My argument is grounded in the redistributionist theory (Acemoglu & Robinson, 2006; Boix, 2003) that there tends to be a national political conflict between the rich and the poor in society. ¹¹ I also follow the literature to assume that political leaders care about their own political survival (Mesquita et al., 2003). In the face of security threats, political leaders must navigate competing social coalitions to reach a fiscal bargain—a war finance strategy that maximizes revenue for war while minimizing social instability.

Because domestic economic inequality generates social and financial instability, it constitutes the upper bound for the revenue that each war finance instrument can extract. More critically, inequality directly contributes to the intensity of the political struggle for redistribution. Therefore, inequality affects the preferences for war finance and strategic interaction of leaders, the wealthy and the public.

Inequality, War Finance Preference and Strategic Interaction

In this section, I spell out how different levels of inequality (low, high, and extremely high) affect the interactions of actors and war finance strategic choices.

War Finance at a Low Level/Declining Trend of Inequality: Equality of Fiscal Sacrifice

When domestic economic inequality is relatively low, or when a country is experiencing a persistently declining trend of inequality, the public’s demand for redistribution as well as welfare programs can be expected to be relatively moderate, so the financial burdens placed on the wealthy are likely to be less painful. In such a circumstance, the public has an incentive to advocate for progressive war taxation while opposing a deficit financing strategy because government borrowing creates opportunities for the wealthy to shift fiscal burdens onto the citizenry in the future. Besides, the majority of the public may support money creation because their own debt burdens may be eased, and nominal wages may rise.

The wealthy elite may advocate reductions in non-military spending because they foresee relatively weaker opposition from the citizenry. The wealthy would hope to avoid progressive taxation, but their opposition becomes less significant because financial burdens may not be too daunting, especially when non-military spending is being cut.

Political leaderships choose war finance strategies based on their monitoring and evaluations of domestic inequality, redistributive conflicts and financial instability. A low level of inequality, or a persistently declining trend of inequality, implies relatively minor social conflicts. Leaders are thus more likely to prefer war taxation because such a strategy could win public support. Moreover, leaders will also consider reductions in non-military spending since they envisage modest public opposition due to relatively low reliance on welfare programmes. Besides, the majority of the public are expected to be appeased by the adoption of progressive war taxation. Furthermore, by cutting non-military expenditures, wealthy elites’ opposition to taxation would also be further mitigated. Finally, a low level of inequality tends to contribute to financial stability (Ahlquist & Ansell, 2017; Kumhof et al., 2015; Piketty, 2014). This allows leaders to pursue money creation without disrupting the whole financial system.

To sum up, a low level of inequality, as well as a declining trend of inequality, paves the way for the political leadership to strike a fiscal bargain that achieves ‘equality of sacrifice’ between the wealthy elite and the public.

These considerations suggest the following hypotheses:

Hypothesis 1: When domestic economic inequality decreases or is at a low level, a state is more likely to pay for war costs by war taxation and money creation as well as by reducing non-military spending.

War Finance at a High Level/Rising Trend of Inequality: A Deficit Financing Strategy

When domestic economic inequality rises and reaches a high level, or when a country is experiencing a rising trend of inequality, the public’s demand for welfare programmes is likely to grow. Hence, the financial burdens placed on the wealthy elite are likely to increase. This may give wealthy elites a stronger incentive to forestall any potentially progressive redistribution policies. In such a circumstance, the wealthy elite would likely oppose war taxation staunchly while eagerly advocating domestic borrowing. Paying for war by borrowing not only eases the wealthy elite’s tax burdens but also provides investment opportunities. More importantly, a deficit financing strategy can create the constraint that puts future welfare expenditures in a straitjacket. Furthermore, the wealthy elite will resist money creation because it puts their financial returns at risk.

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Figure 1.

Source: Author’s own.

The public is likely to strongly oppose reductions in non-military spending since they now have a stronger demand for welfare expenditures. For fear of the wealthy elite’s retaliation, the majority of the public may accede to the wealthy elite’s preferred choice—borrowing. For ordinary citizens, borrowing may be acceptable as a ‘second-best’ option if it can relieve the elite’s pressure to cut social spending.

High inequality breeds more intense social and financial instability. As the financial system becomes more fragile, leaders are less likely to resort to money creation. Being under siege from intensified social cleavages, political leaders would rationally delay redistributive conflict by resorting to borrowing. A deficit financing strategy allows leaders to defuse the majority’s unrest while appeasing the wealthy with potential investment opportunities and lower tax burdens. In Streeck’s term (2014), this is a strategy of ‘buying time’ and delaying the impending regime crisis.

From this theoretical discussion, I propose the following hypothesis:

Hypothesis 2: When domestic economic inequality increases or is at a high level, a state is more likely to rely on a deficit financing strategy (domestic or foreign borrowing) to finance war efforts.

Figure 1 provides a schematic layout of how economic inequality interacts with actor preferences and strategic interactions to create a war finance strategy. When inequality is low or declining, the leadership is more likely to secure a consensus of ‘equality of fiscal sacrifices’ between the wealthy elite and the public. Specifically, the leadership can be expected to more successfully enact progressive taxation, enable money creation and reduce non-military spending to pay for the war. Conversely, when inequality is higher or rising, redistributive conflicts between competing coalitions become more serious. Unable to strike a bargain of fiscal sacrifices without severe social instability, leaders will rationally delay the redistributive conflict by resorting to borrowing.

Pay-As-You-Go versus Borrow to Fight: US War Finance in the Korean and Vietnam Wars

US finance patterns have experienced significant changes during the twentieth century. Indicative of these changes are the differences in how the United States financed the Korean and Vietnam Wars, two wars that share strategic, political and economic similarities. ¹²

US war finance strategies in the Korean and Vietnam Wars strikingly different. Immediately after Communist forces attacked the Republic of Korea in June 1950, Truman called for a $10 billion rearmament programme, and he was determined to adopt a pay-as-you-go approach to finance the Korean War entirely by taxation (Truman, 1950, 1951). Conversely, Johnson preferred a different war finance strategy to pay for the Vietnam War. After the 1964 Gulf of Tonkin incident, Johnson followed President Kennedy’s foreign policy doctrine to engage in defending South Vietnam and decided to escalate in mid-1965. Unlike Truman, Johnson kept shying away from war taxation. Instead, Johnson initially relied on a deficit financing strategy—borrowing to sustain the war effort in Vietnam. Due to the worsening fiscal situation, Johnson was forced to call for tax increases in January 1967, almost two years after the United States escalated the Vietnam War. ¹³ Mounting resistance, however, prevented Johnson from successfully enacting tax surcharges. It was not until 28 June 1968, three months after Johnson announced he would not seek re-election and steps were taken to limit the war, did he finally push through the bill of tax surcharges (Johnson, 1968, 1968). Furthermore, taxation retained a small role in the Johnson administration’s war finance. How do we explain Truman’s and Johnson’s divergent choices when they started the wars? ¹⁴

Changing Trends of Inequality and Redistributive Conflicts during the Two Wars

Historical evidence suggests that changing trends of domestic inequality played a crucial role in determining the divergent patterns in strategies of US war financing in the Korean and Vietnam Wars.

Since the 1929–1939 Great Depression, the United States had experienced a persistently declining trend of wealth inequality until the onset of the Korean War. The top 1 per cent wealth share first dropped from 48 per cent to 38.1 per cent between 1929 and 1932. Later, inequality declined further to 27.2 per cent between 1937 and 1949 mainly due to World War II. This declining trend persisted for a decade as shown by the red line in Figure 2. On average, the changing annual rate of inequality between 1939 and 1949 was –1.42 per cent. Such a trend created an expectation that social resources and power would be shared more equally. The expectation could make collective action problems less onerous to the public. Therefore, ordinary citizens were better able to organize powerful social movements. For example, unions were more capable of launching prolonged strikes with more workers involved before the Korean War. ¹⁵ At the same time, wealthy elites were more likely to concede when the leadership asked them to make sacrifices.

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Figure 2.

Source: World Inequality Database (2018).

However, as the blue dashed line shows, the pattern of inequality trend became different since the mid-1950s. The average annual changing rate of wealth inequality between 1953 (the truce of the Korean War) and 1964 (the year before the Vietnam escalation) was 0.05 per cent. The top 1 per cent wealth share rose from 26.5 per cent to 30 per cent from 1953 to 1966. More importantly, after a decade of the civil rights movement, the Kennedy and Johnson administrations realized that racial inequality had become one of the driving forces of economic inequality. In March 1965, Assistant Secretary of Labor, Daniel Patrick Moynihan, released the famous Moynihan Report, which showed that the non-white population suffered chronic unemployment, low wages, poverty, poor housing and a lack of education (Moynihan, 1965). The combination of widening racial and economic gaps thus prompted Johnson to expand his ‘Great Society’ welfare programs. ¹⁶ Furthermore, increasing concentration of wealth also created more resources for the elites to influence the political process in their favour.

Equality of Fiscal Sacrifice and Truman’s War Finance Strategies

The declining trend of inequality before the Korean War enabled Truman to resort to war finance strategies based on the principle of ‘equality of fiscal sacrifices’. On the one hand, the Truman administration attempted to pay for the war by heavily taxing the wealthy, raising the top marginal income tax rate to 90 per cent and the statutory rate for corporates to 52 per cent (Piketty, 2014). On the other hand, Truman also implemented restrictive measures that put massive burdens on the public and stopped pursuing many of his welfare programmes—the ‘Fair Deal’ (Zielinski, 2016, p. 37). For example, Truman imposed controls on wages, consumer credit and housing credit (Truman, 1950, 1951; Rockoff, 2012, p. 252–254). In the meantime, Truman also enacted reductions in federal domestic expenditures, including public works projects, loan programmes and agricultural price subsidies (Truman, 1950). Truman concluded in his proclamation of the Emergency: ‘…to give effective support to the defense … —credit control, higher taxes, and reduced nonmilitary expenditures — are essential’ (Truman, 1950).

Truman’s insistence on taxation provoked resistance from the financial elites. However, the elites’ bargaining power was relatively weak due to the declining trend of economic inequality. On 2 February 1951, Truman delivered his ‘pay-as-you-go’ special message to the Congress to ask for additional tax increases (Truman, 1951). Truman eventually gained Congressional passage of the Revenue Act of 1951 that raised income and corporate taxes substantially. Even after the Republican Party took decisive control of both the White House and Congress in 1953, financial elites still failed to force any substantial reduction in progressive taxation. As a result, the Korean War was mainly financed by taxation (Rockoff, 2012, p. 249; Zielinski, 2016, p. 45).

Moreover, the Truman administration was able to defend its money creation policy against challenges from the financial elites. Since the war broke out, Thomas McCabe (chairman of the Federal Reserve) and Allan Sproul (vice chair of the Federal Open Market Committee, FOMC), both supported by the financial community, kept informing Treasury Secretary John Snyder about the Fed’s intention to raise interest rates. The Truman administration, however, rejected the Fed’s request by indicating ‘financing of the defence mobilization program should be assured by a stable Federal Securities market’ (Truman, 1951). Then, after the ‘Fed–Treasury Accord’, ¹⁷ was announced, McCabe was immediately forced to resign because Truman considered ‘his services were no longer satisfactory’. (Cargill & O’Driscoll, 2013; Meltzer, 2003, p. 712, footnote 234; Moe, 2014, pp. 54–55).

Truman’s equal sacrifice strategy of war finance could also be found in his handling of labour and industrial disputes. The representative case is the wage bargaining of the steel industry that led to the Truman administration’s steel seizure case (Youngstown Sheet and Tube Co. v. Sawyer, 343 US 579 [1952]). After the Truman administration issued general wage and price controls on 26 January 1951, the steel industry’s revenues suffered a huge blow. This caused a serious distributional conflict: Steel workers asked for wage increases, while steel companies hoped to suppress wages until the removal of the price freeze. As the wage negotiations reached a deadlock, the United Steelworkers of America threatened to strike. Truman was worried that ‘any curtailment of steel production would endanger the lives of our fighting men [in Korea]’ (McCullough, 1992, p. 898). As a result, on 8 April 1952, only hours before the strike, Truman signed Executive Order No. 10340, which directed the Secretary of Commerce to take possession of the steel mills and to keep them operating. This is widely known as ‘the Steel Seizure’ (Truman, 1952). ¹⁸ During the period of seizure, the Truman administration asked for continuing negotiations between management and unions (Ferrell, 1994, p. 371). The final settlement, under Truman’s mediation, asked both management and unions to make sacrifices. Truman was even able to request both parties to show solidarity. According to the New York Times (1952), ‘A novel feature of the understanding is an agreement that the leaders of both the workers and companies’ bosses will make a joint speaking tour to promote improved labor-management relations in United States steel plants’.

The steel seizure decision indicated that declining inequality allowed the government much leeway to navigate social cleavage.

Pursuit of ‘Guns and Butter’ and Johnson’s Deficit Financing Strategy

By the first stage of the Vietnam conflict (August 1964–July 1965), Lyndon Johnson had already received multiple reports about the deteriorating situation. After several evaluations and National Security Council meetings, on 27 July 1965, the Johnson administration finally made the decision to start deploying additional US forces and to escalate the Vietnam War (Califano, 2000, p. 41; Caro, 2012; Foreign Relations of the United States, 1965).

Unlike Truman, Johnson kept shying away from requesting tax surcharges to pay for increased defence spending. The reason was straightforward: He did not want to sacrifice his Great Society welfare programmes. Johnson was worried that calling for war taxation would create the opportunity of cutting his welfare programs by both Republicans and conservative Democrats, most notably Wilbur Mills, who chaired the House Ways and Means Committee. Johnson said: ‘I do know Congress… if I talk about the cost of the war, the Great Society won’t go through and the tax bill won’t go through’ (Bank et al., 2008, p. 131; Gibbons, 1989, p. 389).

The main reason behind Johnson’s war finance choice was the combination of rising economic and racial inequalities. In March 1965, Assistant Secretary of Labor Moynihan released the Moynihan Report on low-income black family life in the United States. He found that ‘the circumstances of the Negro American community in recent years has probably been getting worse, not better’ (Moynihan, 1965; Patterson, 2015). The structural disadvantage of the black population prevented them from enjoying the whole nation’s economic development and prosperity and further exacerbated inequality. Therefore, Moynihan concluded: ‘Equal opportunity for Negroes does not produce equal results—because the Negroes today are a grievously injured people who in fair and equal competition will by and large lose out’.

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Table 1.

Inequality and War Finance Strategy: Truman versus Johnson

Economic Inequality	Truman Administration in the Korean War	Johnson Administration in the Vietnam War
	Declining	Rising
Influence of financial elites	• Weak and diffused • Easily compromised in financial policymaking	• Strong and cohesive • Capable of controlling financial policy
Power of workers and union	• Strong and cohesive • Organized and persistent social movements	• Weak and diffused • Disorganized and short-term social movements
Power of industrial elites	• Weak and diffused • Easily compromised in bargaining	• Strong and cohesive • Capable of resisting government price directives
War finance strategy	Equality of fiscal sacrifice: • Progressive taxation • Cuts in welfare spending • Money creation	Deficit financing strategy

Source: Author’s own.

Worsening inequality increased the public’s dissatisfaction and demand for redistribution, prompting Johnson to continue expanding the welfare programmes. However, increasing concentration of wealth also made the elite stronger and more capable of resisting the government’s efforts to raise taxes. In Johnson’s war finance proposal submitted to Congress, he emphasized: ‘I chose to raise that money (defence spending) without any increases in personal and corporate income tax liabilities’ (Johnson, 1966). Consequently, Johnson was forced to rely heavily on borrowing to save the Great Society while also fighting in Vietnam.

Just as Truman did in the Korean War, Johnson also tried to pursue money creation at the beginning of the war by urging the Fed to maintain a low-interest-rate monetary policy. Johnson made several attempts to sway the Fed, including misrepresenting budget information and even threatening to fire Fed chairman William McChesney Martin. ¹⁹ Johnson’s efforts, however, proved to be in vain. Owing to rising inequality, financial elites had become so powerful owing to rising inequality. The Fed raised interest rates on 3 December 1965, and all Johnson responded was to issue a statement: ‘I regretted but respect the Fed’s action’ (Johnson, 1965).

Johnson’s failure in controlling the elites was also evident when he attempted to stabilize prices. During the Vietnam War, the Johnson administration issued ‘price guideposts/guidelines’ to direct prices and wages, similar to what the Truman administration did in the Korean War. Unlike Truman’s successful intervention, however, Johnson’s strategy was unsuccessful. For example, on 31 December 1965, Bethlehem Steel simply breached the price guidepost and increased prices without informing the Council of Economic Advisers and the Johnson administration was unable to force the company to concede (Johnson, 1965). Because rising inequality had exacerbated societal redistributive conflicts, Johnson was forced to admit: ‘As we all know, we had no power to tell either party (companies or union) what they had to take’ (Dallek, 1998, pp. 306–307).

Conclusion

Historically, wars usually created opportunities for governments to reform their tax systems and achieve tax fairness by introducing progressive taxation. However, since the 1970s, borrowing has become the dominant means for paying for war, while taxation has disappeared from countries’ war finance portfolios. As a result, states’ tax rates, including corporate and estate rates, have been declining for more than four decades. How do we account for the transformation of states’ war finance strategies?

This article develops a ‘redistributionist theory of war finance’ to explain such transformation by focusing on the causal impact of domestic economic inequality. The article argues that the choice of war finance is made through triangular strategic interactions among three key sets of domestic actors: the political leadership, the wealthy elite and the general public. In essence, domestic economic inequality affects the choice of war finance strategy by influencing the conditions for the political leadership to achieve a successful fiscal bargain within society. When inequality is low or declining, the general public’s dependence on social programmes is expected to be relatively mild. On the other hand, the wealthy elite’s expected tax burdens are likely to be moderate. As a result, the political leadership is more likely to secure a consensus of ‘equality of fiscal sacrifices’. Specifically, the leadership could more successfully enact progressive taxation, enable money creation and reduce non-military spending to pay for the war.

To provide the evidence for the argument, this article compares US war finance in the Korean and Vietnam Wars. It shows that the difference between the Truman and the Johnson administrations’ war finance strategies was driven by the divergent trend of inequality. Before the Korean War, inequality in the United States had persistently declined. As a result, Truman was better able to resort to a war finance strategy based on the principle of ‘equality of fiscal sacrifices’. Specifically, the Truman administration raised taxes, cut non-military spending and pursued money creation.

In contrast, prior to the Vietnam War, the combination of a rising trend of economic inequality and worsening racial inequality created a structural constraint—‘guns and butter’—on Johnson’s war finance choice during the escalation of the Vietnam War. Consequently, Johnson needed to rely heavily on borrowing to save the Great Society while also fighting in Vietnam.

This article has two implications for the prospect of human values. First, progressive war taxation used to be one of the main tools to achieve taxation fairness during and after wars. Furthermore, when wars ended, it continued to serve as the fiscal foundation for the modern welfare state. This suggests that if the contemporary pattern of war finance persists, the future for the welfare state and tax fairness is dire. To regain the salience of progressive taxation, a more fundamental structural reform that tackles economic inequality needs to be initiated.

Second, it has long been recognized that states’ reliance on borrowing as the primary war finance strategy might endanger democratic accountability and prospect for peace. For example, Immanuel Kant (1795), David Hume (1752) and Adam Smith (1776) had warned that paying for war by borrowing could be dangerous because it may decrease or even remove public awareness of a government’s action in crisis, dispute or war. As a result, the political leadership may control too much discretionary power to engage in aggression. This may explain why the United States ever launched the protracted and costly ‘war on terror’ in Iraq in 2003 instead of choosing the UN and multilateral cooperation. The direct financial costs of the Afghanistan and Iraq wars amounted to more than $1.6 trillion (Belasco, 2014), or even more than $3 trillion if medical expenses are included (Stiglitz & Bilmes, 2008). Vermont Senator Bernie Sanders criticized as follows: ‘The Republicans took us into protracted wars and ran up our national debt by trillions because they chose not to pay for those wars. Instead, they put the cost of those wars on our national credit card’. Sanders advocated a war tax specifically levied on millionaires (The Hill, 2015). However, the United States failed to raise any war taxes. This article suggests that if the rising trend of inequality and heightened redistributive conflicts continue, the United States, as well as other states, would face more and tougher obstacles in the pursuit of tax reforms and fairness. Even more worrisome is that rising inequality may create the condition for a deficit financing strategy, which enables leaders to pursue aggressive and financially costlier military doctrines and prolonged conflicts.